Author Archives: David Reiss

Treasury Gives RMBS a Workout

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The Treasury has undertaken a Credit Rating Agency Exercise. According to Michael Stegman, Treasury

recognized that the PLS market has been dormant since the financial crisis partly because of a “chicken-and-egg” phenomenon between rating agencies and originator-aggregators. Rating agencies will not rate mortgage pools without loan-level data, yet originator-aggregators will not originate pools of mortgage bonds without an idea of what it would take for the bond to receive a AAA rating.

Using our convening authority, Treasury invited six credit rating agencies to participate in an exercise over the last several months intended to provide market participants with greater transparency into their credit rating methodologies for residential mortgage loans.

By increasing clarity around loss expectations and required subordination levels for more diverse pools of collateral, the credit rating agencies can stimulate a constructive market dialogue around post-crisis underwriting and securitization practices and foster greater confidence in the credit rating process for private label mortgage-backed securities (MBS). The information obtained through this exercise may also give mortgage originators and aggregators greater insight into the potential economics of financing mortgage loans in the private label channel and the consequent implications for borrowing costs.

While this exercise is very technical, it contains some interesting nuggets for a broad range of readers. For instance,

The housing market, regulatory environment, and loan performance have evolved significantly from pre-crisis to present day. Credit rating agency models appear to account for these changes in varying ways. All credit rating agency models incorporate the performance of loans originated prior to, during, and after the crisis to the degree they believe best informs the nature of credit and prepayment risk reflected in the market. Credit rating agency model stress scenarios may be influenced by loans originated at the peak of the housing market, given the macroeconomic stress and home price declines they experienced. The credit rating agencies differ, however, in how their models adjust for the post-crisis regime of improved underwriting practices and operational controls. Some credit rating agencies capture these changes directly in their models, while other credit rating agencies rely on qualitative adjustments outside of their models. (10)

It is important for non-specialists to realize how much subjectivity can be built into rating agency models. Every model will make inferences based on past performance. The exercise highlights how different rating agencies address post-crisis loan performance in significantly different ways. Time will tell which ones got it right.

Hockett on Postliberal Finance

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Bob Hockett has posted Preliberal Autonomy and Postliberal Finance to SSRN. The abstract reads,

Even American Founders whose views diverged as dramatically as those of Jefferson and Hamilton shared a view of finance and of enterprise that one might call “productive republican.” Pursuant to this vision, financial and other forms of market activity are instrumentally rather than intrinsically good — and for that very reason are of interest to the public qua public rather than to the public qua aggregate of “private” individuals. Citizens are best left free to engage in financial and other market activities, per this understanding, only insofar as these are consistent with sustainable collective republic-making. And the republic — the res publica or “thing of the public” — for its part devotes many of its energies to the task of fostering and maintaining a materially independent republican citizenry. State and citizen are thus mutually constituting and mutually supporting, per this vision, and finance is important primarily in its capacity to nurture that symbiosis.

The productive republican view of finance can be illuminatingly contrasted with another view of more recent vintage, which one might call “liberal.” The liberal view takes market activity to be an intrinsic good, if not indeed a matter of inherent political-cum-moral right. Markets on this view are as it were natural social outgrowths of and aggregated counterparts to inherently “free” individual choices — choices that all of us, in both our individual and our collective capacities, are ethically bound to respect insofar as they don’t impose illegitimate costs upon others. So-called “public” interventions in “private” markets are accordingly fit subjects of suspicion and scrutiny per the liberal view. They are presumptively problematic unless and until proven otherwise, while “proof otherwise” for its part typically takes the form of proof that the intervention protects putatively pre-political freedom itself.

I claim in this article, a solicited symposium contribution, that American financial law, and economic law more generally, were once highly productive-republican in character, and that many financial, economic and, in consequence, political dysfunctions with which we have become familiar in recent decades stem from those laws’ having become steadily more liberal in character over time. I also argue that a number of essays, articles, and monographs published over the last twenty years or so under the rubrics of “banking the poor,” “alternative banking,” or “democratized finance” are, in effect if not self-conscious intention, attempts at partial recovery of the productive republican tradition — at least in the realm of finance. They are in this sense what might be called “post-liberal” in sensibility, if not quite in self-conscious aim. Their project can accordingly be aided, I aim to show, by affording them a form of reflective project-consciousness. That consciousness, however, once attained, will not be satisfied with post-liberal finance alone. It will demand a post-liberal economics.

This symposium piece is particularly compelling because it includes a personal story about Bob’s involvement with a “homeless kibbutz.” No spoilers, so you’ll have to read it yourself.

Segregation in the 21st Century

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NYU’s Furman Center has posted a research brief, Race and Neighborhoods in the 21st Century. The brief is is based on a longer paper, Race and Neighborhoods in the 21st Century: What Does Segregation Mean Today? (One of the co-authors of the longer paper, Katherine M. O’Regan, is currently Assistant Secretary for Policy Development and Research at HUD.) The brief opens,

In a recent study, NYU Furman Center researchers set out to describe current patterns of residential racial segregation in the United States and analyze their implications for racial and ethnic disparities in neighborhood environments. We show that 21st Century housing segregation patterns are not that different from those of the last century. Although segregation levels between blacks and whites have declined nationwide over the past several decades, they still remain quite high. Meanwhile, Hispanic and Asian segregation levels have remained relatively unchanged. Further, our findings show that the neighborhood environments of blacks and Hispanics remain very different from those of whites and these gaps are amplified in more segregated metropolitan areas. Black and Hispanic households continue to live among more disadvantaged neighbors, to have access to lower performing schools, and to be exposed to more violent crime. (1)

And the brief concludes,

Black and Hispanics continued to live among more disadvantaged neighbors even after controlling for racial differences in poverty, to have access to lower performing schools, and to be exposed to higher levels of violent crime. Further, these differences are amplified in more segregated metropolitan areas. Segregation in the 21st century, in other words, continues to result not only in separate but also in decidedly unequal communities. (5)

This conclusion makes clear that segregation is not merely the result of poverty. It is important to understand how segregation persists even though the legal support of segregation has been dismantled. Richard Brooks and Carol Rose’s work in this area is a good start for those who are interested.

Washington’s Farewell

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President Washington had this to say in his farewell address:

The unity of government which constitutes you one people is also now dear to you. It is justly so, for it is a main pillar in the edifice of your real independence, the support of your tranquility at home, your peace abroad; of your safety; of your prosperity; of that very liberty which you so highly prize. But as it is easy to foresee that, from different causes and from different quarters, much pains will be taken, many artifices employed to weaken in your minds the conviction of this truth; as this is the point in your political fortress against which the batteries of internal and external enemies will be most constantly and actively (though often covertly and insidiously) directed, it is of infinite moment that you should properly estimate the immense value of your national union to your collective and individual happiness; that you should cherish a cordial, habitual, and immovable attachment to it; accustoming yourselves to think and speak of it as of the palladium of your political safety and prosperity; watching for its preservation with jealous anxiety; discountenancing whatever may suggest even a suspicion that it can in any event be abandoned; and indignantly frowning upon the first dawning of every attempt to alienate any portion of our country from the rest, or to enfeeble the sacred ties which now link together the various parts.

We should heed these words as much today as in Washington’s own time. And while they should guide us in many areas, I would focus on what they mean in the context of housing finance reform.

Democrats and Republicans have not found common ground on the future of Fannie Mae and Freddie Mac. And yet the nation is likely to be made worse off by leaving them in limbo for so long, with a variety of crises lurking just over the horizon. I hope Congress can hear Washington’s advice to his fellow citizens and commit to placing the reform of these two gargantuan financial institutions at the top of its agenda for the coming year. Seems like a good way to truly commemorate his contribution to our country.

Reiss on $1.5B S&P Settlement

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Westlaw Journal Derivatives quoted me in S&P Settles Fraud Suits for $1.5 Billion. The story reads in part,

Standard & Poor’s has agreed to pay $1.5 billion to settle lawsuits filed by the U.S. Department of Justice, 19 states and a pension fund that accused the ratings agency of damaging the economy by inflating credit ratings in the years leading up to the 2008 financial crisis.

According to a statement issued Feb. 3 by S&P, a subsidiary of McGraw-Hill Cos, the ratings agency will pay $687.5 million each to the DOJ and the states. It also will pay $125 million to settle a lawsuit filed by California Public Employees’ Retirement System. Cal. Pub. Employees’ Ret. Sys. Moody’s Corp. et al., No. CGC-09-490241, complaint filed (Cal. Super. Ct., S.F. County July 9, 2009).

The parties filed a joint stipulation of dismissal with the U.S. District Court for the Central District of California on Feb. 4.

“After careful consideration, the company determined that entering into the settlement agreement is in the best interests of the company and its shareholders and is pleased to resolve these matters,” McGraw-Hill said in the statement.

S&P did not admit to any wrongdoing in agreeing to settle.

U.S. Attorney General Eric Holder announced the settlement for the Justice Department and states.

“On more than one occasion, the company’s leadership ignored senior analysts who warned that the company had given top ratings to financial products that were failing to perform as advertised,” he said in a statement.

*     *     *

David Reiss, a professor at Brooklyn Law School, also said the settlement closes an important chapter of the crisis.

“S&P would have faced a lot of unquantifiable risk if it had to admit wrongdoing in the settlement,” he said. “It is unclear that the Justice Department would have wanted to expose one of the three major rating agencies to such a risk because it could have destabilized the rating agency industry.”

Reiss added that the $1.5 billion settlement should have a deterrent effect.

”[It] likely gives ratings analysts some firm ground to stand on if they are pressured to lower their standards by others in their organizations,” he said. (1, 18-19)

The article also has a sidebar that reads,

Ratings agencies had avoided liability for their actions for quite some time based on the theory that they were First Amendment actors who dealt in opinions.

Recent cases have held that the rating agencies can be held liable for some of their ratings notwithstanding the First Amendment. United States v. McGraw-Hill Cos. et al., No. 13-CV-0779, 2013 WL 3762259 (C.D. Cal. July 16, 2013) and Federal Home Loan Bank of Boston v. Ally Financial Inc. et al., No. 11-10952, 2013 WL 5466631 (D. Mass. Sept. 30, 2013).

For instance, if the rating agency did not follow its own rating procedures, it could be held liable for fraud.

—David Reiss, Brooklyn Law School (18)

Realistic Strategies for Consumer Education

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The Consumer Financial Protection Bureau has issued its latest Strategic Plan, Budget, and Performance Plan and Report. I was critical of last year’s strategic plan as it related to financial education. I felt that the CFPB was too optimistic about the efficacy of financial education, given the current state of research on this topic.

I was impressed, however, by the CFPB’s approach in this year’s strategic plan:

The CFPB believes that financial education’s primary goal is to help consumers to take the steps necessary to make choices that will improve their financial well-being and help them reach their own life goals. However, prior to the start of the CFPB’s work, very little empirical research had been conducted in the financial education field regarding what variables measure financial health in terms of real-world outcomes for consumers. By defining these variables through data-driven research, the Bureau will be able to define what knowledge and skills are associated with financial health. This research will inform the Bureau’s ongoing efforts to identify, highlight, and spread effective approaches to financial education. (64)

I am pleased that the CFPB appears to be more skeptical about the efficacy of consumer education in this strategic plan and that is reflected in its performance measure:

FY 2013: Identify variables that are likely to be key drivers of financial health

FY 2014: Develop and test metrics (questions) that accurately measure these variables

FY2015: Develop and implement framework for integration into Consumer Education and Engagement Activities; Complete testing financial health metrics

FY2016: Use metrics to establish a baseline of U.S. consumer financial well-being and begin testing hypotheses of identified success factors in consumer financial decision-making (64-65)

This performance measure does not make assumptions about the efficacy of financial education. By treating the topic like a blank slate, it is more likely that the Bureau will be able to avoid dead ends and blind alleys as it attempts to help people to navigate the world of consumer finance.

This is not to say that the Bureau will necessarily be successful.  But it does appear that the Bureau is not falling for some of the wishful thinking that some of those in the financial education field have succumbed to.

Nation of Renters

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NYU’s Furman Center and Capital One have produced an interesting graphic, Renting in America’s Largest Cities. The graphic highlights the growing trend of renting in urban communities, but also the increasing expense of doing so. The press release about this study provides some highlights:

  • In 2006, the majority of the population in just five of the largest 11 U.S. cities lived in rental housing; in 2013, that number increased to nine.
  • As demand for rental housing grew faster than available supply, rental vacancy rates declined in all but two of the 11 cities, making it harder to find units for rent.
  • Rents outpaced inflation in almost all of the 11 cities. Rents Increased most in DC, with a 21 percent increase in inflation-adjusted median gross rent, and least in Houston, where rents were stable.
  • In all 11 cities, an overwhelming majority of low-income renters were severely rent-burdened, facing rents and utility costs equal to at least half of their income.
  • Even In the most affordable cities in the study, low-income renters could afford no more than 11 percent of recently available units.
  • In five major cities, including New York, Los Angeles, San Francisco, Boston and Miami, moderate-Income renters could afford less than a third of recently available units in 2013.

Rental housing clearly has an important role to play in providing stable homes for American households, particularly in big cities. While rental housing has been the stepchild of federal housing policy for far too long, it is good that it is finally get some attention and resources.

I look forward to the Furman Center’s follow-up report, which will provide more detail than the graphic does. I am particularly curious about whether the researchers have addressed the difference between housing affordability and location affordability in the longer study. I would guess that the relative affordability of the cities in this study is greatly impacted by households’ transportation costs.